Every day, articles appear urging Americans to save for retirement, mainly by illustrating how many save too little – or not at all. These articles often turn to thorough and wide-ranging studies. For example, the latest Federal Reserve Survey of Consumer Finances reported that in 2013 only about 45% of U.S. heads of household ages 25 to 64 had balances in retirement accounts.
These articles are so prevalent that it seems like retirement planning is only about saving. Though clearly saving early and often is the key first step in building a retirement nest egg, it is not the only element you need to achieve financial independence in retirement. Investment performance and risk management are also essential ingredients.
There is however, another important aspect commonly overlooked: the eventual spending plan or budget for all the money you accumulated.
In retirement, inattention to household spending can have serious consequences. Ameriprise Financial in 2016 asked more than 1,300 savers ages 55 to 75 if they had a drawdown (retirement withdrawal) strategy for the future. Nearly two-thirds did not. A third of the retired respondents also lacked spending plans.1
Spending plans or budgets for retired individuals, like the spending policies for endowments and pension plans, are the guidelines for how much will be drawn quarterly from the retirement account. A newly retired couple can travel too much, eat out too frequently and live it up to such a degree that their savings can be drawn down abruptly. This is particularly a danger when investments perform poorly due to common market volatility, or worse if a retirement account suffers a large drawdown like many experienced in the economic busts of 2000-2001 or 2008-2009. A sound spending plan may help retirees guard against the adverse impacts of such crises.
Another dangerous scenario occurs when a retiree household becomes overconfident in its decently performing portfolio and its middling level of savings. A decade or so into retirement without a spending plan, that household can find its investment and bank accounts dwindling mysteriously fast. Sunday brunches give way to $3.99 bacon-and-egg specials; the golf clubs stay in the garage all year.
A plan for drawing down retirement savings in moderation when retirement starts increases the probability of sustaining a quality of life longer throughout retirement.
There is no standardized retirement drawdown strategy. Each retired household (and its retirement planner) must arrive at one strategy specific to its savings, investment mix, income requirements, and age. Though many planners commonly reference the 4% annual withdrawal rate 3%, 3.5%, 5% or some other amount may work best for you.